Boettke on Shleifer.

Recently I commented on a new paper by Andrei Shleifer titled The Age of Milton Friedman. Now I see that Peter Boettke has an interesting comment on the same paper at The Austrian Economists blog. At one point Boettke writes,

First, we have to recognize that while there may be macroeconoimc questions, there are only microeconomic solutions. Second, we have to recognize that attempts to pursue command and control strategies with the policy tools of old Keyensianism (fiscal and monetary policy) are counter-productive for long term growth and economic development.

I can't help but agree with Boettke on these points. I had a similar thought as Bottke's point (1) when working on the so-called "knowledge economy". If there is something new in the "knowledge economy" due to the effects of information and communication technologies (ICTs) it will show up in the macroeconomic data but that data will require a microeconomic explanation. As an example consider the so called "productivity slow down". This shows up in the macro data but its explanation must have to do with the effects of ICTs on investments in human capital and labour markets along with the interrelated changes ICTs bring to the organisation and operations of firms. The changes that show up in the productivity data are the result of the creation, adoption and diffusion of ICTs though the economy. This in turn depends on the incentives facing firms and individuals within the economy. Such incentives depend on the institutional framework that these firms and individuals interact within. As Douglass North has written,

What is missing in the new growth economics literature in the incentive structure of the society, a critical weakness to that body of theory since it is the incentive structure that has been the basic determinant of an economy investing in the human and physical capital that determines sustained economic growth.

The incentives are a function of the institutional structure of society. (North 1997: 2)

As to the second point, Shleifer makes the argument in his paper that reliance on market forces within an open economy in a stable macroeconomic environment, with assured property rights, are the keys to rapid economic growth. But Adam Smith said it before him,

Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes and a tolerable administration of justice.

The traditional policy tools of the old Keyensianism when applied around the world seem to work in the opposite direction. Over the last 30 years tax have been increasing, at least in New Zeland, the ratio of tax to GDP have been increasing over the last 30 years. In 1975 New Zealand's ratio was 28.5%, in 2005 it was 37.8%. Protectionist forces are always with us, eg the Obama and Clinton battle over which of them is the strongest critic of NAFTA. Property rights are under increasing attack, eg the Kelo v. New London case in the US or the Resource Management Act in New Zealand, and peace is not about to break out any time soon in many places around the world.

But all is not lost. As Shleifer writes of the example of Ireland,

As much as any other country in the world, Ireland embraced the prescriptions of Milton Friedman: trade openness, low taxes, low regulations, and balanced budgets. "The main lesson from the Irish experience is that there are certain key prerequisites necessary to sustain high growth – namely, sound macroeconomic policies, a strong commitment to free trade, a lightly regulated competitive microeconomic environment, and a well-educated and flexible labor force (p. 285)." Starting as one of Western Europe’s laggards, Ireland became the richest country of the region in the span of one generation.

The stranglehold of Keyensianism can be broken. If only the New Zealand government could see this point.

• North, Douglass C. (1997). The Process of Economic Change, UNU/Wider Working Paper no. 128, March.